You can't "upgrade" the original xandros OS, because it is too old.
You can install a newer version of linux.
Small distros like D
inux or puppy
should fit easily.
Ubuntu netbook remix (10.04 has long-term-support, 11.04 is the "latest") might be worth looking at.
For ubuntu with gnome and a lot of other stuff, I needed an extra 1GB, so I now have 15GB available for /home
once I added a 16MB SD card.
For different linux distros see http://distrowatch.com
For eee-related stuff, see the links I gave you in post #2
Installation of linux is not difficult. As the eee doesn't have a CD rom, you'll have to boot the installer from a USB stick